Itaú BBA - Growth to remain low for another year

Scenario Review - Chile

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Growth to remain low for another year

December 7, 2015

A less-intense depreciation and a sluggish economy would help to bring inflation down.

Please see the attached file for all graphs.  

• For 2016, we now expect even milder economic activity recovery of 2.3% (2.5% previously), from the 2.0% expected for this year. This would be the third consecutive year of low growth as the Chilean economy adjusts to low copper prices.

• While some additional appreciation of the U.S. dollar is likely globally in 2016, copper prices are likely to recover, limiting the weakening of the Chilean peso. We see the exchange rate reaching 715 pesos per dollar by the end of 2016, from the 700 expected for the end of this year. However, average copper prices in 2016 will be lower than we were previously expecting. That, added to the downward revisions in the time series for the external accounts, led us to increase our forecast for the current-account deficit to 1.7% of GDP both this year and the next.

• A less-intense currency depreciation next year would ease tradable inflation, which, along with the sluggish economy, would help to bring inflation down. We see inflation ending 2016 at 3.5%, following the 4.5% estimated for the end of this year.

• We expect the central bank to increase its reference rate in 1Q16 to 3.50%. With inflation decelerating,anchored inflation expectations and weak growth, further hikes are unlikely.

• The debate on the education and labor reform bills will likely extend into 2016.

No major recovery in 2016

For 2016, we now expect even milder economic activity recovery of 2.3% year over year (2.5% previously), from the 2.0% expected for this year. This would be the third consecutive year of low growth as the Chilean economy adjusts to low copper prices. In addition to the worsened environment for commodity exporters, monetary and fiscal policies will be less supportive next year. As uncertainty about the implementation of reforms decreases, a modest recovery in sentiment is likely, helping to lift growth.

The economy is already showing some improvement. GDP for 3Q15 grew 2.2% year over year, up from the 1.9% recorded in 2Q15. The rolling four-quarter growth rate increased to 2.1% from 1.8% as of 2Q15 (1.9% in 2014). The demand-side breakdown for 3Q15 shows improved fixed-investment performance (after several quarters of negative growth) and heightened government consumption as the fiscal stimulus unfolds, while net exports continue to contribute negatively to activity. Private consumption, the driving force behind activity until 2014, expanded at a lower rate than GDP for a fourth consecutive quarter. Sequentially, activity accelerated to 1.8% qoq/saar, from -0.3% in 2Q15. Domestic demand grew 4.5% qoq/saar (1.0% in 2Q15), pulled up by government consumption (9.0% qoq/saar) and gross fixed investment (24.6% qoq/saar).

A wider current-account deficit

We expect the Chilean peso to show a less-intense weakening next year, as copper prices are set to show some recovery from current levels, partially offsetting the additional strengthening of the U.S. dollar. We expect that the exchange rate to reach 715 pesos to the dollar by the end of 2016, from the 700 expected by the end of this year. The evolution of the Chilean peso has become a source of concern to the central bank, as inflation remains high. Recently, Governor Rodrigo Vergara highlighted the flexible exchange-rate regime in Chile, but noted that the central bank retains the right to intervene under “exceptional” conditions.

Recent revisions to the external-account time series together with our new scenario for copper prices (which imply lower average prices in 2016 than we were previously expecting) led us to increase our forecast for the current-account deficit in 2016. We now see a deficit of 1.7% of GDP (-0.1% previously), stable from the expected deficit for this year (previously, we were also expecting a deficit of 0.1% of GDP for 2015). In 3Q15, the current-account balance deteriorated from one year before, after eight consecutive quarters of improvement. The four-quarter rolling deficit is now at USD 2.7 billion (-1.1% of GDP), a deterioration from the revised USD 1.7 billion deficit (-0.7% of GDP) as of 2Q15 (USD -3.0 billion or -1.2% of GDP in 2014). The four-quarter rolling trade balance of goods and services deteriorated, and now sits below the 2014 print. Meanwhile, the income deficit measured in dollars is gradually narrowing. Net direct investment is still more than enough to fully finance the current-account deficit.

Lower inflation in 2016

Inflation came in slightly below expectations in November. On an annual basis, inflation was 3.9%, the lowest reading of the year. Core inflation remained above the upper bound of the target, at 4.7%.

We see inflation ending 2016 at 3.5%, following the 4.5% expected for the end of this year (4.8% previously). A less-intense currency depreciation next year would ease tradable inflation, which, along with the sluggish economy, would help to bring inflation down.

Gradual stimulus removal

In November, the Central Bank of Chile held its policy rate at 3.25%. Nevertheless, the statement of the decision maintained a tightening bias. The minutes of the meeting show the board also considered raising rates by 25 basis points. However, board members thought that a second consecutive hike could conflict with the baseline scenario in the 3Q15 Inflation Report (IPoM) – which only incorporated one hike through the end of this year – and, consequently, with the guidance of a gradual stimulus removal. The board seems attached to the roadmap outlined in the IPoM: a hiking cycle totaling 50 to 75 bps.

We expect the central bank to increase its reference rate in 1Q16 to 3.50%. Given our expectation of exchange-rate stabilization, low growth and inflation moderation, a policy rate above 3.5% during 2016 seems unlikely.

Reform debate to continue next year

The approval of the labor reform may happen only next year. After 11 months of discussion, the workers’ confederation and left-leaning political parties in the governing coalition are pushing to approve the labor reform bill by the end of this year, while the center-right opposition and more moderate factions of the government do not see this as a possibility. There are still fundamental differences between both sides, especially dealing with the effect of stronger collective bargaining at SMEs and worker replacement during strikes.

On the educational-reform front, there is still uncertainty about when the free higher education bill will be presented to congress. Additionally, the government’s plan to provide free higher education next year to a fraction of those who qualify on financial grounds is being questioned at the constitutional court, on ground of possible discrimination, potentially delaying the reform’s progress.

The public deficit will fall very gradually in 2016. We expect a deficit of 3.2% of GDP next year, a slight improvement from 3.3% estimated for 2015. The 2016 budget was approved, incorporating real expenditure growth of 4.4%. Regarding the assumptions used in the budget, Finance Minister Rodrigo Valdes has noted that next year’s 2.75% growth forecast “is pretty close to being achieved,” but added that the copper price is now lower than expected (USD 2.50 per pound projected). The government is estimating a nominal deficit equivalent to 3.2% of GDP for next year.


 

João Pedro Bumachar
Miguel Ricaurte

Vittorio Peretti


 

Please see the attached file for all graphs.  

 



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